Inflation, endogenous quality increment, and economic growth

This study explores the effects of monetary policy in a Schumpeterian growth model with endogenous quality increment and distinct cash-in-advance (CIA) constraints on consumption, manufacturing and R&D investment. When the CIA constraint is only on consumption, an increase in the nominal interest rate may stifle economic growth by lowering the arrival rate of innovation and stimulate it at the same time by raising the size of quality increment. An additional CIA constraint on manufacturing weakens the growth-retarding effect and enhances the growth-promoting effect, whereas an additional CIA constraint on R&D strengthens only the negative growth effect. Our quantitative analysis finds that the relation between inflation and growth is generally hump-shaped, but the welfare effect of inflation is negative.